Rather Short Book Review: Philip Coggan's 'Paper Promises'

by Matthew DeBord

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Philip Coggan is a very fine financial journalist with a real gift for providing clarity on a dense subjects and reducing the complex sweep of history to easier-to-understand structures. In the "Buttonwood" column he writes for The Economist, he routinely accomplishes this feat. In "Paper Promises: Debt, Money, and the New World Order," he ramps up that habit, taking a long look at the legacy of relationships between debtors and creditors while also offering a warning about the next major global financial crisis. (Hint: It involves China and the U.S.)

He starts off with a bang:

The massive debts accumulated over the last forty years can't be paid in full, and they won't be paid. The debt crises Of Greece, Ireland and Portugal are just the start. The economic outlook for some countries, particularly in Europe, is weak thanks to deteriorating demographics: the number of retirees is growing relative the number of number of workers. As a result, these countries' incomes wil not grow fast enough to service their debts. Either there will be foramal defaults...or there will be effective defaults....Economics and politics for the next decade and beyond will be dominated by this issue, as social classes and countries debate where the brunt of the pain will fall.

Ouch! Coggan then moves on to an explanation of how our money system arose and how it works. And then he gets to the good part: breaking down the structure of global trade and exchange over the 20th century and into the 21st. It goes roughly like this: Great Britain, when it was an imperial power and running the world economy, created a stable gold standard that, by the time World War I was over and World War II looming, had broken down. The gold standard was dropped and the post-World War II Bretton Woods system (named for the town in New Hampshirte where it was negotiated) was developed, with fixed exchange rates replacing currency that was backed by gold reserves. The United States took the lead here, although the primary intellect at Bretton Woods was the British economist John Mayard Keynes, whose ideas had helped the West escape the Great Depression.

Importantly, the U.S. dollar became the most important world currency in this fixed-rate system, but it was still related to gold. So instead of everyone running their currency based on gold, they ran it based on a "peg" to the dollar, which was itself still on a sort of last-resort gold standard, for reasons of confidence and reluctance to completely abandon gold, more than anything else. One thing Bretton Woods accomplished was that it constrained excessive debt, and by doing so kept global balance of payments from getting out of whack. As Coggan puts its, "trade deficits could not last forever (indeed that is why the system broke down)."

By the early 1970s, Bretton Woods had come under stress and officially collapsed when Richard Nixon said "See ya!" to the gold connection. After this, currencies all floated in terms of their exchange rates against each other, although many countries kept a peg to the dollar, in effective making the USD a kind of meta-gold.

We all know what happened next. Once the inflationary crisis of the 1970s was resolved, 40 years of debt expansion occurred, ending (sort of) during the financial crisis. The result was a humongous mess that still hasn't been cleaned up.

The U.S. is now financing enormous budget deficits largely by soaking up the dollar reserves of its main creditor, China. As Coggan repeatedly points out, this is an inevitable function of the role of the dollar as the the effectively global reserve currency. If you want to have the reserve currency, you have to run an balance-of-payments account deficit in order to keep enough currency circulating to ensure liquidity in the system (it's called the Triffin paradox, after the economist who identified it in the early 1960s). In other words, people always have to be able to exchange their whatevers for dollars — much as they could exchange them for dollars, and then for gold, under Bretton Woods. And before Bretton Woods, for gold.

This is all good and bad for the U.S. Because we issue debt in our own currency, we can easily devalue our debt. Martin Wolf, the Financial Times' august finance columnist, argues that this is what the U.S. has been doing for a while — basically "defaulting" on its debt by forcing its creditors to accept a weaker dollar as the world's exchange currency. He who holds the gold used to call the shots. Now it's he who can print the dollars.

Anyway, this all gets very complicated. If you think about currencies and exchange rates, it will eventually give you a headache. Which is exactly what it's done to the world. No one likes that the U.S. is stuck being the world's largest debtor. However, no one else is in a postion to provide the reserve currency — not even China, which is probably a decade or two from that ability. However, as Coggan argues, history always puts debtors and creditors into unresolvable conflict. So the crisis, she is a-comin'! And it will feature the U.S. giving up its Bretton Woods status as the one calling the global economic shots.

BUT — and it's a big BUT — China doesn't necessarily want to step in and be the new U.S., with the ultimate responsibility to offer a new reserve currency (Been there, seen somebody else do that!). Coggan thinks China will set the rules, which could mean that we get a wish Keynes made back at Bretton Woods: the creation of a global currency (he called it, in a nice moment of worldy anglo wit, the "bancor") that everyone can peg itself to.

Coggan doesn't take a position on this, not directly — and why would he, given the politically intractable "world government" overtones? But he does seem to have a very slight soft spot for the gold standard, or at least something akin to the way that the Bretton Woods system kept gold around as a check on excessive balance-of-payment imbalances. This is somthing that, at any rate, I consistently detected lurking between the lines as I read the book. You could call it nostalgia. Or you could call it a sensible aversion to the debt explosion of the past four decades.

Coggan's final, decisive verdict on all this is completely unflinching: "paper promises" will be broken. No way out of it, under it, or around it. "In the last forty years," he writes, "the world has been more successful at creating claims on wealth than it has at creating wealth itself." That's an impeccably simple and very Cogganian way of summing the situation up. He's under no illusion about how much trouble this is going to cause. "The global economy is changing," he states. "[and] for many in the West, it will not be for the better."

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